Bankruptcy Is A Serious Risk For Tesla Motors

Date: 16/09/16

Kumar Abhishek, Amigobulls

Since the day Tesla signed the agreement to acquire SolarCity the number of people who are predicting Tesla’s doom has ballooned. Many investors believe that the deal will be ruinous for both the companies, especially for Tesla. And the market agrees with them to a large extent. Tesla stock has slumped 14% while SolarCity has slumped more than 30%.

The main issue weighing on the stocks is the cash crunch. The 2008 crisis has taught us well about the importance of liquidity. However great your vision may be, to reach there you need to survive now.

On Tuesday, well-known short investor, Jim Chanos, who had successfully bet against Enron, weighed in. To quote him “The bottom line is that Tesla, which was slightly above the red line, puts itself well under the red line by buying SolarCity,”. Earlier in June, he had described the SolarCity deal as the worst example of corporate governance. As we have covered in an earlier post there were many corporate governance issues relating to the merger. Mr. Elon Musk was the largest individual shareholder in both the companies, SolarCity CEO Lyndon Rive is his cousin, and the two boards are so related that only two of the board members of SolarCity were able to go through the deal process.

The Cash Flow Problem

While corporate governance issues are definitely a cause for concern, there are immediate existential issues facing Tesla. The company is a huge cash guzzler and so is SolarCity. The company needs tons of cash to survive and adding another cash guzzler only adds to the risk. In 2015 Tesla burned around $500 million of cash in operations. And in the first two-quarters of 2016 the company has burned $350 million. The free cash flow position is even worse with the latest quarter’s free cash flow coming in at -$610 million.

This comes at a time when Tesla needs more cash to expand its gigafactory and Model 3 production. Tesla has planned to spend more than $1.5 billion in the second half. This will put Tesla’s liquidity under serious stress. And if you add SolarCity’s burden then the risk increases even more. In the latest quarter SolarCity had around $250 million in cash on its books while cash burn from operations was more than $380 million. And the way it is going, SolarCity will still need a huge amount of cash. To quote Chanos:

“The combined SolarCity and Tesla, which we think will have a cash burn of a$1 billion a quarter, will constantly need access to capital markets.” “To burden your own balance sheet with the kind of business … strikes us as the height of folly.”

The recent deal by SolarCity to raise $305 million in equity has come as a great relief to the market. While there are some concerns about the conditions associated with the equityt issue, in the end, the deal will give SolarCity more time to live. According to reports SolarCity was so cash-strapped that it was about to collapse during the negotiations.